The impressive year-to-date rally in the stock market is about to crumble, according to Goldman Sachs.
The bank said the S&P 500 has more downside than upside between now and the end of the year due to high valuations and weak earnings growth.
“The debt ceiling deadline later this year adds uncertainty to the path for US stocks,” Goldman said.
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Goldman Sachs is growing more and more skeptical of the impressive year-to-date rally in the stock market, according to a Friday note.
The S&P 500 is up more than 7% year-to-date and eclipsed the all-important 4,000 price level two weeks ago. But according to Goldman, 4,000 is about as far as the S&P 500 is going to go between now and the end of the year.
That’s because a soft landing and above-trend growth is already priced into US stocks, and valuations are still at historically elevated levels.
“Even if a soft landing comes to fruition, as in our baseline forecast, such an outcome should not lead to substantial equity market upside,” Goldman Sachs’ chief US equity strategist David Kostin said.
Meanwhile, the S&P 500 currently trades at a forward price-to-earnings ratio of 18.4x, “and at an even higher ‘effective’ multiple if one accounts for the fact that most investors appear to expect earnings well below those of analyst estimates,” Kostin explained.
That means the current price-to-earnings multiple falls in the 87th percentile since 1976, according to the note.
“Valuations are elevated vs. history and will be constrained by an eventual rise in interest rates. Even avoiding recession, earnings are unlikely to grow substantially in 2023,” Kostin said.
Kostin expects S&P 500 earnings per share to flatline in 2023 and grow 5% in 2024. That’s compared to consensus estimates calling for 1% growth this year and 12% growth in 2024. “Based on our conversations, equity investors are largely aware that consensus estimates are too high,” Kostin said.
Kostin did raise his three-month S&P 500 price target to 4,000 from 3,600, but kept his year-end price target unchanged at 4,000. A decline to 4,000 represents potential downside of 3% from current levels.
While the stock market appears rich, there are plenty of alternative assets that appear attractive, according to Kostin, which include international stocks, fixed income, and cash.
Another unknown is the potential volatility related to the US debt ceiling. Legislators have until June to strike a deal to raise the borrowing limit or have the US default on its debt. That, combined with a potential recession, means US stocks aren’t a great deal to investors right now.
“The combination of limited upside in our base case and substantial downside risk if the economy dips into recession makes for a challenging distribution of outcomes for US equity investors, especially relative to the alternatives,” Kostin said.
In a hard-landing economic scenario, Kostin expects the S&P 500 to fall to 3,150, which represents potential downside of 24% from current levels.